8 ways to protect yourself from risks of non-QM lending.
A year ago, the big question was, "Will we do non-QMs?" Then, volume dropped to a 17-year low and lenders started looking to squeeze income out of anything they could- the question became, "How will we do non-QMs safely?" (because obviously we're going to offer non-QM products. Of course, the "small creditors" out there are just laughing about this.
No one needs a reminder on the risks involved with non-QM lending--the liability and other risks are scary. But if you have decided to offer some non-QM products, here are some thoughts on how to do so safely ... some things we'd like to share from what we've seen across our client base.
1.Price Up for Risk
Early estimates place this at 12 - 40 BP per non-QM loan (that's on price, not yield). If you want to offer non-QM products, you can use this to create reserves for future problems.
2.Temporary "QM QC"
We see lenders reviewing loans for QM compliance and submitting reports to management and even the Board. This is not intended to last forever, but to provide peace of mind perhaps during the first year that we're living with QM.
3.Historical Underwriting Standards Report
Remember the question is whether it was "reasonable" for you to think the borrower could repay the loan. What better evidence is there than a case study analyzing the prior performance of your loan portfolio that was underwritten to the same standards you follow today? The key is to look at how the loans performed during bad economic times--that's what the regulators or courts will be looking for. If you can say, "We had a sub-1% delinquency rate on loans during the recession using the same underwriting standards we have today", then you can definitely prove that it was "reasonable" for you to follow those same standards today. But Note: Be prepared to tighten your underwriting standards if necessary. For example, your research might show a high delinquency rate on loans with FICOs under 700 and DTI over 47. In this example, you'll have a hard time defending it as "reasonable" for you to do a 650 loan with a 50 DTI today with the QM rule.
The report helps either way: either (a) it supports your decision to keep your underwriting standards and offer non-QMs if they happen to fall outside the QM box, or (b) it will identify areas where you need to make your underwriting standards more stringent.
4.Require Higher Standards for Non-QM Borrowers
What many lenders have decided to do is only offer non-QM products to certain, unusually low credit risk borrowers. Some examples include only offering non-QM products to borrowers with a prior relationship with the lender, with an especially high FICO, or a borrower with a significant amount of other assets available.
5.Separate ATR Determination
We know, the loan file is already too big! Nonetheless, one thing we've seen lenders do is provide a separate "ATR Determination" file that specifically says, "We [LENDER] have determined in good faith that the borrower has the reasonable ability ... etc. etc. .... according the following factors:" The document goes on to address each of the mandatory factors briefly and explains why it supports making the loan, e.g. "The borrower's credit score is 800. In the last 15 years, we've never had a delinquency on a loan with an 800 score. Therefore, this makes it more likely the borrower can repay the loan."
6.Residual Income
This has the potential to help reduce much of the risks with non-QM lending (and certainly on higher-priced QMs that don't get the full safe harbor). But at what cost? What will it it take operationally to implement residual income underwriting? And the CFPB is not approving of institutions simply adopting VA standards--you'll need to adapt it to your specific locale. A residual income policy also requires careful attention because of potential fair lending risks. If you're denying borrowers because of a lack of residual income, be prepared to document this thoroughly--typically, a borrower with 50% DTI on an $800,000 loan is going to have more residual income than a borrower with 50% DTI and a $100,000 loan.
7.Training
Training helps in obvious ways, e.g. employees following the rules and making it easier to comply. It will also help demonstrate the "good faith" you need to meet the QM rule's requirements.
8.Prepare QM Defense Ahead of Time
Here's an idea that's been floating around. If a borrower challenges his mortgage in 7 years on the grounds of ATR/QM, what will happen? His attorney will pull all the documents, your attorney will pull all the documents. They'll argue about it, etc. The idea is to streamline this process and handle as much of it as possible before handing it off to the lawyers. We've seen draft letters for a "first response" to the consumer: "We believe we complied with the ATR/QM rule because .. XYZ." All the relevant documents could be organized ahead of time, saving a lawyer time combing through every file. By the way- the historical standards report (above) would also be included and help give your attorney more leverage.
Other news/thoughts/trivia:
Go here to find out which banks got the most CFPB complaints this year --- is your institution on there?
The CFPB's 120-day rule continues to frustrate compliance- folk, with the ABA submitting a letter requesting information that may be worth a read.
There's some buzz about a report from the Fed appearing to support the general criticism that the CFPB's 2014 mortgage regulations have hurt mortgage volume.
The FDIC has dropped their "high risk" list--apparently, when the FDIC says "watch these people extra carefully," many institutions interpreted this to mean "don't ever make loans to any of these people." Looks like some telemarketers, those in the pornography business, coin dealers, and those affiliated with online gambling companies can breathe a sigh of relief.
You can't always predict the future. I try to think of it as if I'm just guiding a ship generally in the right direction. But you can be humble and keep an open mind:
"We don't like their sound, and guitar music is on the way out." Decca Recording Company on declining to sign the Beatles (1962)
"I think there is a world market for maybe five computers." Thomas Watson, Chairman of IBM (1943)
"The horse is here to stay but the automobile is only a novelty a fad." The President of Michigan Savings Bank advising Henry Ford's lawyer not to invest in the Ford Motor Co. (1903)
"It'll be gone by June." Variety Magazine on Rock n' Roll (1955)
"You can't learn in school what the world is going to do next year."
- Henry Ford
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